THE WATCHDOGS THAT DIDN’T BARK
Royal commissions tend to go places that no one expects.
In 1980, Australian prime minister Malcolm Fraser established a royal commission into the Federated Ship Painters and Dockers Union, a notoriously criminal outfit that controlled the country’s ports. They held sway over nearly everything that came in and out of Australia. This was enough to irk the government, but many members of the union, including at its highest ranks, were also engaged in a wide array of criminal activities.
The Liberal government of the day was encouraged to launch the royal commission after a number of media reports detailed serious misconduct by members of the union. In 1981, during the Costigan royal commission, all eleven Painters and Dockers officials in Victoria had criminal records (with an average of twenty-three convictions each) and nine had served prison sentences.
Its own members were not beyond the reproach of the union. Victorian secretary Jack ‘Puttynose’ Nicholls was found dead in his car with a suicide note nearby on the day he was meant to appear before the royal commission to answer allegations that he’d been involved in the murder of his predecessor, Pat Shannon, in 1973. According to one of Puttynose’s mates, the secretary was about as likely to commit suicide as he was to take ballet lessons.
Headed by Frank Costigan, QC, the royal commission soon uncovered gross amounts of social security fraud, compensation fraud, theft, extortion, the handling of massive importations of drugs and shipments of armaments, and all manner of violence and murder. Despite the public outcry for action against members of the Dockers, many of whom went around Melbourne with impunity as they killed and stole, the commission was decried as a politically motivated witch-hunt by Labor and the union movement.
It was easy to see how it was painted as a show trial. The Liberals had a longstanding battle with the union movement. Constant airings of violent dealings in the Dockers would probably serve to secure Fraser a re-election, based on pledges to clamp down on union intransigence.
But not everything went according to plan. It’s why there’s an adage that you should never hold a royal commission unless you already know the outcome.
Costigan began to uncover corporate Australia’s biggest little secret, and Fraser was caught off guard. Along the course of its investigation, the royal commission stumbled upon one of the most infamous tax scams in Australian history. There was a widespread practice of asset-stripping of companies to avoid tax liabilities, and it was facilitated by members of the Painters and Dockers Union. Thanks to the Dockers’ reputation for criminal bastardry, wealthy businessmen outside the union stooped to harness the unionists’ criminal prowess to achieve their own questionable ends.
The tax scandal was known as the ‘bottom of the harbour’ schemes because some tax records were thrown into Sydney Harbour to be destroyed, and it brushed up on some of the governing Liberal Party’s nearest and dearest supporters. In a rort that stretched back decades, about $3 billion was estimated to have been stripped from government revenue each year thanks to the tax avoidance scheme—a cost of about $600 for every working Australian, in 1980s prices.
The trick was that before a company’s tax fell due, the group would be stripped of all its belongings and profits and then transferred to the directorship of a person who had little interest in its past dealings.
In many cases, this person was a member of the Dockers Union, who would collect a fee along the way for his part in the scam. The company would then be bankrupted and sunk to the metaphorical bottom of the harbour, out of the reach of the Australian Taxation Office. One man identified by the commission had been named a director of 2000 companies.
While Fraser had hoped to shut down a rogue element of the union movement in an exercise that would hopefully ricochet across to a few prominent Labor politicians, the tax dodge became the centrepiece of the royal commission.
The Spectator wrote in 1983 that in the context of the tax scheme, the Painters and Dockers were ‘far too thick’ to understand what was going on and began to look like innocent bystanders. ‘Trade unions may be corrupt, but only amongst themselves,’ the magazine wrote.
Meanwhile, the Liberals started becoming the victims of their own inquiry. The tax schemes were employed by some very powerful corporate Australians, many of whom were connected to the party. More importantly, they were among the Liberal Party’s biggest donors. Media mogul Kerry Packer, whose own magazine The Bulletin had been instrumental in forcing the Costigan royal commission, was even enmeshed in the scandal.
Under pressure over the tax avoidance revelations, Fraser’s government, through its treasurer, John Howard, was forced to introduce retrospective legislation ending the rort. Some in the party never forgave Fraser. Then, when Labor leader Bob Hawke came to power, he shut down the royal commission before it finished its inquiry.
The whole endeavour serves as a reminder to governments that if they start to ask tough questions, they might not like the answers they get.
After months of ugly revelations at Kenneth Hayne’s royal commission, the chairman of the banking regulator made an unusual interjection into the debate about standards in the financial industry.
At a Sydney business luncheon in July 2018, APRA chairman Wayne Byres gave an address ostensibly to declare that APRA’s mission of shoring up standards in the $1.7 trillion mortgage sector had been accomplished. This was a curious enough claim, but it was just the pretext for a secondary, more curious spiel.
Byres went on to tell the crowd that it was about time consumers took more responsibility for themselves when engaging with a financial company. ‘It is important that the concept of caveat emptor remains in the system,’ he said. Caveat emptor is Latin for ‘buyer beware’.
‘Regulators cannot be everywhere overseeing everything. It is important the community understands that,’ Byres said.
He was right. Regulators could not be everywhere. But his comments, though lauded by the Financial Review as a ‘timely reminder’ of the financial industry’s reticence to be held responsible for its own failings, were met with reservation by the industry Byres was meant to be policing.
A few days after the comments were made, Westpac chief executive Brian Hartzer told a luncheon that the concept of caveat emptor did not absolve banks from selling dubious products. Indeed, Westpac had been slowly culling the products it had found to be directly in contravention of good customer outcomes. By July 2018 it had reviewed 320 products and made over 150 changes, cutting the number of products on sale by more than half.
‘Almost all financial services products involve an element of risk,’ Hartzer said. ‘When you buy a term deposit, when you buy a share in a company, when you buy a bond, you are taking on some risk. If you inadvertently end up in a situation where nobody can ever take a loss, that will dramatically end up changing the economics for everyone. It is a topic that deserves to be highlighted. At the same time, we absolutely agree that we should not lend money to people who clearly can’t afford it. We should not put people into investments that are unsuitable.’
While the main thrust of Byres’ argument was correct—of course APRA was not an all-seeing, all-powerful regulator—it missed the point. The problem wasn’t that APRA wasn’t across every instance of misconduct all the time: the truth was that the regulators were often nowhere to be found at all.
In his interim report handed down just a month after Byres’ comments, Commissioner Hayne made it clear who was responsible for failing to punish much of the misconduct unearthed by the inquiry. ‘When misconduct was revealed, it either went unpunished or the consequences did not meet the seriousness of what had been done,’ he said. ‘The conduct regulator, ASIC, rarely went to court to seek public denunciation of and punishment for misconduct. The prudential regulator, APRA, never went to court.’
Nowhere was this absence of court action more evident than in the $2.7 trillion superannuation sector.
In March 2014, APRA had been given a stunning breach notice by Commonwealth Bank’s superannuation arm, Colonial First State. While it had been aware of changes in the law requiring it to create low-fee MySuper accounts to handle the savings of its least engaged members as early as 2011, CBA had failed to make the proper arrangements by the deadline and had pushed 13,000 customers into its high-fee legacy products. The bank later discovered the number was actually 15,000. Each one was a criminal offence. (See Chapter 10 for a detailed examination of this.)
APRA had all the evidence it needed to take the bank to court, get remediation for customers, and send a message to the rest of the industry that this type of behaviour would not be tolerated. But that was not what happened. APRA didn’t even demand that the customers be transferred immediately to the low-fee fund. Instead, the regulator oversaw a process that allowed members to be transferred over more than three years, during which time Colonial continuously broke the law. Call centre transcripts, which showed how customers were misled into choosing the high-fee fund, were even reviewed by APRA, but the regulator gave CBA the tick of approval. It asked the bank to appoint an independent consultancy to review the process of transferring the members, and after twenty-four updates from Ernst & Young on the remediation, the breaches of the law ended three years later, in September 2017. On that date, APRA officer Nick Johns emailed Colonial thanking it for sending a copy of Ernst & Young’s report. ‘We have no further queries and consider this item closed,’ APRA said.
Colonial boss Linda Elkins admitted to the royal commission that the call centre communications with customers were misleading, but APRA didn’t seem to care. Brought into the witness box at the Federal Court, APRA’s head of superannuation, Helen Rowell, refused to admit the communications were misleading, saying, ‘I think … more complete communication to the members would have been desirable.’
Taken to another misleading call centre script, she said it did not ‘provide complete information to the member to enable them to make their choice or decision’. Michael Hodge, QC, asked if that was an acceptable outcome from APRA’s perspective. ‘It’s not desirable,’ Rowell said.
‘It’s not desirable? Surely it’s unacceptable from a regulator’s perspective?’ Hodge shot back.
‘It would be preferable if there was a complete disclosure to the members,’ Rowell said.
It wasn’t just CBA that got off lightly. APRA was aware of other, smaller breaches of the same law requiring members to be moved to low-fee MySuper funds, but never prosecuted any company for the crime. In fact, there was a whole range of poor behaviour in the super sector that APRA never sought to clamp down on. It was as if the companies were the prisoners in the scene towards the end of Monty Python’s Life of Brian when they are lined up before they are marched off to be crucified.
As each prisoner comes forward under instruction from the guard, they are asked whether they are there for crucifixion, to which they dutifully reply that they are. Good, responds the prison guard, who then sends them out the door, to their left, to collect one cross each.
That is until one responds, with a straight face, that he’s not there for crucifixion but to be set free. He says he’s been told he hasn’t done anything wrong and can live on an island somewhere. The guard is momentarily confused, but tells him, ‘Jolly good, and off you go.’ The prisoner laughs and confesses he is only pulling the guard’s leg and he actually is there to be crucified, and he is sent out the door to his left to collect his cross like the other prisoners.
APRA seemed a bit like the guard who was fooled by the straight-faced prisoner. Even when super funds told APRA they were guilty of the crimes, it let them go free. Even when APRA was aware of poor behaviour in the superannuation sector it wanted to end, funds simply ignored the regulator. And when super funds dismissed APRA’s concerns, it did nothing to clamp down on the intransigence.
A year before the royal commission began, APRA had created a hit list of about twenty-eight funds that had underperformed across most or all of a range of different metrics. They were charging high expenses and high life insurance fees, reporting poor investment returns, and suffering large levels of outflows of cash or churning of member numbers. While about two-thirds of the funds subsequently engaged by APRA either worked to address the issues or struck up deals to merge with better funds, the remaining third refused to take on any of the regulator’s demands and dug in their heels.
The original hit list included bank-owned for-profit funds, not-for-profit funds and both public and non-public funds. When those funds refused to engage with APRA, the regulator didn’t take any further steps.
One industry fund, First Super, even launched a public campaign defending its position as it faced pressure from APRA to merge. The $3 billion fund generated very good investment returns but its membership, which included 64,000 workers in timber, pulp and paper, furniture and joinery businesses, was ageing and employed in dying industries. As its membership dwindled, sooner or later First Super would be hit with ever-increasing costs to perform the same duties.
‘The big funds, some regulators and some media commentators would like Australians to believe that only funds over a certain size can possibly compete in the market,’ First Super chief executive Bill Watson said as he celebrated small super funds in the wake of the royal commission’s examination of the sector in August 2018. Feeling emboldened by the failure of the commission to damage the industry fund sector, First Super took the moment to revel in itself. While APRA preferred to keep its regulatory approach behind closed doors, here was an example of a fund publicly rebuking it.
As the Productivity Commission began investigating the superannuation system as part of its landmark 2016 review, questions were asked of Rowell’s appetite for action. APRA knew who the bad funds were, so why not pick one retail fund, one industry fund and one corporate fund and take all three to court over failing to act in members’ best interests?
Rowell is said to have slapped down the idea: ‘That’s not how we operate.’ Under her stewardship, APRA was a behind-closed-doors operator. However, this was proven to be an ineffectual way of operating.
More, APRA had a blind focus on ensuring only that super funds did not collapse, allowing the companies to engage in less-than-ideal behaviour as long as it didn’t threaten their prudential stability. This was entirely misguided: the taxpayer already underwrote the risks in the system.
When it handed down its final report, the PC shot down APRA and ASIC for their failure to protect the nest eggs of working Australians. It said the roles of the regulators were unclear, they were too slow to act, they needed to take more legal action, and they should be more focused on members’ interests.
‘Members would have a realistic expectation that government and regulators would ensure their fund is looking after them, but this expectation would have been sadly misguided—with no regulatory disposition nor effective mechanism in place for weeding out underperforming funds and products,’ the PC said.
‘It is clear that strategic conduct regulation with deterrence intent—where public enforcement action in response to material member harm is undertaken to deter similar behaviour by others—has generally appeared either largely “missing in action” or been “too little too late”. The “behind closed doors” nature of APRA’s supervisory activities means that there is little potential for demonstration effects.’ These effects would have included court action or public denunciation of poor behaviour that would have both cracked down on misconduct and sent a message to other funds contemplating stepping out of line.
Rather than allowing bad funds to continue to operate in the market, the commission urged the regulators to make the funds prove their ‘right to remain’ in the system. To ensure this would happen, the PC proposed a tough hurdle known as an ‘elevated outcomes test’. At its core, the test would force APRA to continually monitor the performance of super products as measured against a benchmark target that was customised to a fund’s own asset allocation. This way, funds would not be unfairly punished if they had a more conservative investment strategy, but would face regulatory action if they failed to deliver performances on par with better-performing funds that were investing in the same instruments.
The royal commission revealed that many retail funds continued to outsource management to their own divisions even when they knew their own divisions were long-term underperformers. However, when APRA was given the opportunity to adopt the elevated outcomes test, it squibbed it in favour of a far weaker proposal. Launching its member outcomes rules in November 2018, a month before the PC finalised its proposals and as Kenneth Hayne was drafting his final report for the royal commission, APRA gave funds guidelines that incorporated soft investment return targets that appeared to allow laggards to set dismal targets and game the system.
‘The regulators appear focused on funds and their interests, and not on whether members’ needs are being met and their interests unharmed,’ the PC said. At its core, the commission said, the ‘caveat emptor approach that has guided much regulation to date is both inappropriate and inadequate’. For anyone who cared about shoring up standards, the laissez-faire attitude wasn’t going to cut it anymore.
Under pressure while being hammered by the royal commission and the PC, APRA needed to put a head on a spike. Luckily, it had a big, smiling face in mind. In fact, it had five candidates. In December 2018, it filed a Federal Court legal suit against IOOF’s managing director Chris Kelaher, chairman George Venardos, chief financial officer David Coulter, general manager legal, risk and compliance Paul Vine and general counsel Gary Riordan. They were not fit and proper people to run a superannuation company, APRA said.
Finally, APRA was publicly denouncing poor behaviour. In its statement, it said the IOOF directors had ‘each demonstrated an inability to properly identify and appreciate conflicts of interest; a lack of understanding of obligations under the SIS Act [Superannuation Industry (Supervision) Act] and the general law; and a lack of contrition in relation to the breaches’.
Behind closed doors, APRA had been demanding IOOF shore up its standards since 2015. A few days after the suit was filed, Kelaher and Vernados reluctantly agreed to step aside from the company while the court case was underway. Public actions were finally getting results.
Interest-only loans had surged to a heady 18 per cent of all outstanding mortgages and were a ‘ticking time bomb’ according to financial regulators, which have put in place severe curbs on lending and are now requiring banks to check more regularly with borrowers who may have no plans to pay down their loans.
The preceding sentence describes a situation that sounds familiar, but it was actually the situation in the UK in 2018, where the Financial Conduct Authority had, since 2012, taken extraordinary steps to rein in loose standards in the banking sector after finding that interest-only loans, which don’t require repayment of a loan’s principal amount for a period of generally five years, had helped to fuel a housing boom before the 2008 GFC.
Back in Australia, it couldn’t have been more different. APRA ditched its own crackdown on interest-only loans in December 2018, getting rid of the restriction that these loans had to make up—at most—30 per cent of all new lending (double the level the UK regulators were uncomfortable with). APRA’s rule had been in place for only eighteen months.
When the royal commission triggered a tightening of lending standards in the banking sector that then fed through to falling house prices across the nation, financial watchdogs grew increasingly concerned. APRA decided to declare its mission of restoring stability to the financial system accomplished. The temporary cap had done its job, and if banks wanted to start lending out interest-only loans again, APRA believed deposits would now be larger and borrowers would be able to repay their mortgages.
But in comparison to the UK’s financial watchdogs, which had learned the lessons of the crash, APRA was shown to be asleep at the wheel. The Australian regulators had waited until interest-only lending accounted for nearly 50 per cent of all new loans in the market. And it wasn’t just fringe operators hawking the risky products, which have the capacity to trap people in large loans they have little ability to repay—about half of the loans in Westpac’s $400 billion portfolio were held on an interest-only basis.
The UK has continued to demand higher standards of its banking sector, with one eye on the time bomb of hundreds of billions of dollars’ worth of loans due to mature in coming years when those loans switch from interest-only to principal-and-interest. At that point, monthly repayments will jump by about 50 per cent, and customers who are already under financial stress, or close to it, will find themselves unable to afford repayments.
In Australia, regulators threw in the towel on higher standards out of a fear the local property bubble was bursting. More than $300 billion of interest-only loans in Australia are due to expire over the few years to 2023, and without the ability to refinance into another interest-only loan, APRA and the RBA are worried about a large-scale rise in loan defaults. However, rather than ensuring the longer-term resilience of the financial system by requiring a permanent lift in standards, the regulators decided it was easier to keep borrowers in a perpetually revolving line of credit in which they are never expected to repay their loans.
Many of the borrowers are investors, with more than three-quarters of interest-only loans being taken up by property speculators by the start of 2017. Under negative gearing laws, investors could deduct the interest payments from their tax bill, meaning they were hardly paying a dollar out of their own pocket on the loan, and then flip the property when they were happy with their price gain.
APRA’s ditching of the rule came not long after the Reserve Bank showed interest in ensuring the housing bubble didn’t inflate too much further. In a speech in April 2018, assistant governor Chris Kent said the value of interest-only loans as a product had its limits: ‘For housing investors, the key motivation for using an interest-only loan is clear. By enabling borrowers to sustain debt at a higher level over the term of the loan, interest-only loans maximise interest expenses, which are tax deductible for investors.’ They also helped fuel surging house prices across Australia, which has left the country with the second-highest rate of household indebtedness in the world.
After the royal commission shamed the sector over its nonchalant approach to compliance with responsible lending laws, the banks withdrew from the lending market. Loan applications became more thorough and credit decisions were often overturned by wary banks. But APRA now appeared less concerned about whether the banks were complying with responsible lending laws than whether the sector was simply lending or not.
The intervention was also bungled from the beginning. Since introducing the 30 per cent interest-only cap, borrowers barred from the APRA-regulated sector had flooded into the shadow non-banking sector where there were no limits. Over the eighteen months the rule was in effect, the shadow banking sector grew at its fastest pace in a decade.
Standards are even lower in the non-bank sector while interest rates are significantly higher, leaving the non-regulated industry a larger weakness in the body of the financial system than it was before the interest-only intervention. APRA had been given powers to regulate the shadow banks, but chose not to use them.
The whole episode made the government’s decision to prevent Hayne’s royal commission from any investigation into ‘macro-prudential’ policymaking by financial regulators seem prescient. However, the intervention was emblematic of the approach the regulator had always taken towards the banks. APRA was too late off the mark, and then it was too ready to throw in the towel when things got tough.
Just before Christmas 2015, Byres attended a meeting with Commonwealth Bank executives. He was there to deliver an unequivocal message: CBA’s financial success had made it arrogant.
The bank had presided over the biggest housing boom in history. Its profits were soaring and executives were reaping the reward. But APRA had that year launched a secret prudential review of CBA’s risk management framework and found several large gaps. Byres wanted to warn the bank in person about the need to overhaul its behaviour. He found a bank board that had insulated itself against criticism, and later characterised it as having been ‘bureaucratic and arrogant’ in the meeting.
APRA decided against making the findings of its review public, and because its failings were kept secret, CBA saw no reason to improve its behaviour. Months later, it was hit by the CommInsure life insurance scandal, and then, a year later, with the AUSTRAC money-laundering Federal Court case.
It wasn’t until the camel’s back was broken that APRA decided to go public, launching a transparent ‘prudential inquiry’ into the bank’s culture and governance. That inquiry found that CBA’s industry-beating profits had ‘created a collective belief within the institution that CBA was well run and inherently conservative on risk, and this bred overconfidence, a lack of appreciation for non-financial risks, and a focus on process rather than outcomes’. The report also outlined how the bank had continually thumbed its nose at the regulator. CBA had shown a ‘reluctance to proactively volunteer information on matters of regulatory concern’ and there were ‘frequent delays in compliance with regulatory requests’, according to the review.
The prudential review of CBA was a watershed moment for the financial industry. Although it singled out CBA for being guilty of ‘complacency’ and having a ‘reactive stance’ to issues rather than being prudently responsive to changing tides, the rest of the financial sector was put on notice over the report. APRA would make all financial institutions mimic the cultural review and return their own findings to the regulator by late 2018.
But it was too late for the banking industry. Australia had already forced a royal commission on the sector for its decade of negligence.
When it was Byres’ turn to sit in the royal commission dock, the chairman was forced to reconcile APRA’s knowledge of the mounting scandals at CBA in 2016 with its lack of action against the bank. APRA should have done more to pressure the board on its pay structures, which were seen to be driving the poor outcomes, he admitted, but it lacked expertise in analysing banker remuneration. It wasn’t confident to take on CBA over poor risk culture, conduct or pay matters because it didn’t have ‘sufficient expertise’, he said. Rather, the regulator’s primary interest was one of supervising banks’ capital and stability.
‘We didn’t have a lot of expertise in remuneration,’ Byres said. ‘It was an area that is not the natural forte of a prudential supervisor. We were talking to CBA a lot on mortgages; mortgages are bread and butter.’
For banks, however, governance standards are one and the same with financial stability.
The world’s second-largest bank, the US-based Wells Fargo, was hit by a scandal in 2016 where it had created two million customer accounts fraudulently after bank staff were pressured to sign up new customers to meet their bonus KPIs. Although there was little financial damage caused by the creation of the fake accounts, the bank was blasted with regulatory penalties, restrictions on its growth and a plunge in its stock price. The scandal also caused institutional investors to take their money elsewhere, risking the ability of the company to source funding. It was a cultural scandal that resulted in weakening the bank’s financial stability.
When CBA’s cultural pulse had shown signs of flatlining, APRA had neglected its duty. This included the CommInsure debacle. When APRA held a routine meeting with CBA in late 2016, six months after that scandal had broken, Byres decided not to raise the issue with the bank. ‘We went to that meeting thinking we didn’t have to rub their nose in it,’ he said.
APRA’s job depended on financial institutions being honest and open with it. If it was too hard on the banks, it feared it wouldn’t be told about important matters. It often assumed that the conduct regulator, ASIC, would be on the case. If one watchdog was thought to be chasing poor behaviour across the sector, it wouldn’t make sense to double up the work. Byres even said it could be ‘clumsy’ to have two regulators investigating the same misconduct.
‘I think what we would say is we’ve got another regulator that is looking at, essentially, the same facts, the same documents, the same actions, overlap of people,’ he said. ‘It’s actually inefficient and sometimes unhelpful to have two regulators investigating the same thing at the same time.’
That may be the case, but the issue wasn’t that there were two regulators turning the screws on rogue behaviour in the sector. The issue was that there was none.
In 2011, when ANZ hatched a plan to make its front-line branch staff convince customers to sign over their superannuation to the company, it knew it was a risky strategy. Under the law, ANZ branch staff were only allowed to provide ‘general advice’ about super. This meant they were only able to give general advice and facts about ANZ’s own super fund. They could not assess whether the product was suitable for the customer or compare it to the customer’s existing fund.
Still, ANZ saw a big opportunity in convincing people to roll over their retirement savings into its own funds.
The bank’s own legal officers were wary of the plan, labelling the ‘inherent risk’ of the strategy as ‘extreme’. ‘It is possible that regular breaches of incidents would be seen by the regulator as “systemic”, putting ANZ’s licence at risk,’ the lawyers’ internal presentation to the bank said.
Despite warnings it could be stripped of its ability to operate as a financial institution, ANZ proceeded with the plan anyway. Why wouldn’t they? ASIC was a toothless tiger.
Between 2012 and 2016, ANZ sold $2.6 billion worth of super accounts through its branches. And when ASIC came knocking, the bank was proven right—despite sitting on super savings that had ballooned to $3.6 billion by 2018, ANZ was slapped with a penalty of just $1.25 million. Its financial services licence was never under threat.
When Commonwealth Bank’s CommInsure division had been misleadingly telling their customers they were covered for heart attack when in reality they were covered only for the most severe of heart attacks, the bank faced an $8 million penalty under the law. Comm-Insure had been pushing the misleading advertising for four years to 2016, but instead of pursuing the bank for the full penalty, ASIC decided it would make it pay a ‘community benefit payment’ of just $300,000. The soft touch didn’t end there. As it was wrapping up its work on its investigation, ASIC’s head of enforcement, Tim Mullaly, emailed CommInsure a copy of the regulator’s draft media release on the matter, wanting the insurer to get back to him and let him know if ‘this is sufficient to CommInsure to resolve’ the investigation.
Why was ASIC, the supposedly tough cop on the beat, allowing companies to workshop its media releases?
In fact, it was a shamefully regular practice at the watchdog. After a two-year freedom of information battle with ASIC, my colleague Ben Butler unearthed a series of documents revealing the very same behaviour between the regulator and the banks. Over nearly a decade, the corporate regulator regularly bowed to demands from the biggest financial institutions in Australia to water down the language in its press releases.
The releases issued related to some of the biggest scandals to hit the sector, including a financial planning snafu that hurt the retirement savings of up to 560,000 Commonwealth Bank and Macquarie customers and sparked calls for a royal commission nearly four years before Kenneth Hayne was asked to inquire into the sector.
CBA’s chief lawyer, David Cohen, was closely involved in drafting a 2014 press release about fresh licence conditions that had been slapped on the bank’s financial planning arm. In his previous posting as AMP’s head legal officer, Cohen had sent ASIC a two-page list of ‘issues we have with ASIC’s draft media release’ after the regulator found the company was shunting its financial advice customers into its own in-house products 93 per cent of the time. ASIC accepted many of Mr Cohen’s changes. The regulator appeared quick to buckle under pressure.
In a 2014 review of the wealth management sector, as ASIC worked on a press release about customer losses from investment platforms, a worker in the regulator’s media unit emailed colleagues: ‘This is one of those releases that has been drafted by everyone other than ASIC ha!’ ASIC appeared to be too trusting of the companies it was supposed to be regulating.
Both APRA and ASIC stood in direct contrast to the way the ACCC went about its business. When the Rod Sims–chaired ACCC saw something it didn’t like, it dragged the relevant company before the courts without so much as a courtesy call. If the ACCC lost the eventuating legal suit, it would then publicly argue for the law to be changed—if it couldn’t enforce the law, it wasn’t the ACCC’s fault, it was up to the legislation to be able to be enforced by a regulator. Under pressure from the ACCC, the government would be dragged to the table and forced to amend the law.
ASIC took a far more ‘consultative’ approach to the new ‘unfair contracts’ law that came into force in November 2016. This law would put smaller companies on a more equal footing with big business when negotiating contract terms. The ACCC’s approach to enforcing similar legislation in its remit was far more rigorous. In early 2017, ASIC deputy chairman Peter Kell said that if the regulator found ‘a potentially unfair term we will work with the lender to remove or amend the term’. On the ACCC’s side, a year before the contracts law came into force, it began demanding sample contracts from companies it regulated. If they were incorrect, they would be punished. ASIC considered doing this but decided not to, choosing instead to wait until the banks had reviewed their contracts and then see if they complied with the law.
‘Why work with the lender? Why not just say, “Do it”?’ Hayne asked ASIC’s head of credit, Michael Saadat at the royal commission.
Saadat said there were too many lenders with too many contracts to be able to conduct such a big sweep. ASIC lacked the resources to go through every contract. ‘If the lender is prepared to make changes in response to the concerns we have raised, that can be a quicker process than going down the road of taking court action,’ Saadat said.
A lack of time and resources also appeared to keep ASIC from ensuring that dodgy financial advisers were kicked out of the industry. ASIC senior executive Louise Macaulay, who was responsible for overseeing discipline of financial advisers, told the royal commission the regulator was doing as much as it could, given its resources. While it may have seemed easy to kick bad apples out of the sector, it was an arduous process and a legal minefield. ASIC took about two years to ban a dodgy adviser, and had never attempted to fine any advisers for their misconduct.
Macaulay told the commission that investigations of adviser misconduct were resource intensive and often heavily contested by the targeted planners. Even when they were flagrantly disobeying the law, companies bogged down the regulator in legal warfare over the expulsions. ‘We find even in the jaw-dropping cases, commissioner, defences are put on, material is put on that was not in the file … to explain why the advice was good advice,’ she said.
When it did ban a financial adviser, ASIC was hamstrung in sending a stern message to the rest of the industry. Australia’s notoriously fickle defamation laws prevented the regulator from airing details of misconduct lest it be bogged down again in a subsequent trial over damage to a planner’s reputation.
The dodgy financial adviser problem was only set to worsen. As the major Australian banks sought to carve off unprofitable or troublesome divisions such as financial planning arms, there would be an increasing number of advisers outside the ranks of the big four banks and AMP. This meant tracking bad behaviour would be much harder for a regulator that lacked the resources even to tackle misconduct in the larger, more professional firms. It didn’t have the time or the money to investigate the hundreds or thousands of fringe operators in the market.
It also didn’t have the time or the money to spend days in the courtroom, especially when it was up against some of the most profitable financial giants in the world. ASIC chairman James Shipton called it ‘legal trench warfare’. When hit with accusations of misconduct, banks and their well-armed teams of lawyers would fight back against even the slightest suggestion of indiscretion.
And why wouldn’t they? The big four banks made a combined profit of $30 billion in 2018. They could afford the best silks in town to defend the most indefensible of cases. When ASIC was weighing up legal action, it had to factor in how much of a bruising it would take during a fight. The default mode for the major banks was to ‘vigorously defend’ any case brought against it.
Take for instance the bank bill swap rate rigging saga. When ASIC began targeting the banks over their practice of manipulating the key interest rate benchmark, it scored several early wins. Royal Bank of Scotland paid $1.6 million to clear up allegations from ASIC, and Swiss giant UBS and France’s BNP Paribas both paid $1 million over the scandal.
However, when it came to the big four Australian banks, they sought to block the regulator at every stage of the fight. ASIC filed cases against CBA, Westpac, ANZ and NAB over a drawn-out two-year period as it built its case against each lender.
Despite initially defending themselves against the claims, ANZ and NAB folded after a few months as it became clear they would spend an inordinate amount of money fighting a case during which they were likely to suffer significant brand damage. Westpac held steady and forced ASIC into a lengthy proceeding; it was eventually found guilty on a number of the allegations made in the Federal Court lawsuit, with a minor victory on several other alleged breaches of the law. ANZ and NAB were proven correct—the scandalous chatroom banter about Westpac’s traders who had attempted to manipulate the interest rate was splashed across newspaper headlines for months.
CBA, which was the last bank to face ASIC action over the rate-rigging behaviour, initially said it would defend itself in court against the allegations. That was until its new chief executive, Matt Comyn, had second thoughts. By mid-May 2018, CBA was less enthusiastic about going to war with ASIC, and settled the case out of court.
Taking the big four banks to court over rate rigging was the career highlight of former ASIC boss Greg Medcraft, who had faced continual criticism over the impotence of the financial watchdog under his leadership. When Shipton replaced Medcraft in early 2018 after a storied career as a top executive at Hong Kong’s financial regulator, he was determined to kick ASIC into gear. However, he soon realised why Medcraft had had such a difficult time keeping the financial sector on a tight leash.
When Shipton sat in the royal commission box, he argued that there were decisions ASIC was forced to take when it wanted to rein in bad behaviour, and it had to make these decisions only because the government refused to hand over more money to properly fund the watchdogs.
‘It weighs very heavily on the regulatory choices that we have to make, because it means that we are restricted in our ability to take on matters or to pursue matters in a way that, perhaps, we would like to,’ he told the commission. ‘We are constrained in probably every aspect of our regulatory work. It’s certainly in investigations, certainly in other matters relating to enforcement. We are constrained in our surveillance, our supervision, our important work on financial capability and other work.’
Australia wanted a tough watchdog, but the royal commission showed that the government was not prepared to feed it.
In October 2018, ASIC was due to make a routine appearance before a joint parliamentary committee. The MPs on the committee were given no forewarning of what Shipton had in store, but the executives at ASIC had been cooking up a plan to go nuclear on the regulator’s funding. Rather than coming cap in hand, Shipton hauled in buckets that were open for donations.
Commissioner Hayne’s interim report had been made public just weeks earlier, and in it he had singled out the regulators for failing to properly curtail bad behaviour in the financial system. ASIC was sick of being a punching bag. It had been effectively neutered by successive governments, including a particularly harsh budget cut of $140 million made by the Abbott Government in 2014. Despite rendering the watchdog impotent by constraining its funding, the government had immediately attacked it over the failures aired during the royal commission. It was demanding that the regulator put no foot wrong at the same time as freezing it into a state of inaction by squeezing it of the funding it needed to litigate against the biggest corporations in Australia.
‘Now is the right time to ask whether ASIC should be resourced differently to meet the community’s expectations and the unique challenges of Australia’s financial system,’ Shipton told the joint parliamentary committee. ‘Now is the right time, and this is the right forum … to discuss whether ASIC and its peers are “right-sized”. This question is not a statement, nor a demand. It is instead a question aimed at starting an important policy conversation.’
In Shipton’s old stomping ground of Hong Kong, financial regulators were funded to be three times as large as Australia’s in terms of how much money they were given compared to the number and revenue of the companies they sought to regulate. Just on unadjusted numbers, regulators in Hong Kong had a combined budget that was 50 per cent bigger to regulate an industry that was a third the size of Australia’s.
ASIC received tens of thousands of complaints and mountains of breach notifications every year, but it had to handle this workload with an enforcement team that numbered less than one-third of the workforce of the tiny ACT police force. With ASIC’s expenses close to $400 million a year, APRA running at $130 million and the ACCC budget costing taxpayers $200 million, a tripling of funding could take the expense for the main financial watchdogs to close to $2 billion a year.
Under the government’s industry funding model for ASIC, the regulator’s budget was constrained by the level the government decided to appropriate it in the budget, which was then paid back by the industry it regulated. While the financial industry was indeed covering the cost of regulation, the overall level of funding kept the regulator hemmed in. It could only do what it could with the level of funding nominated by the government each year, leaving it reactive to changes in the regulatory environment and pinching pennies where possible.
While the government was urging ASIC to take more action against bad behaviour, ASIC didn’t have the funds to take people to court. It declared it lacked the cash to fund the expected fifty criminal and civil prosecutions to be launched against rogue executives and corporations over the two years following the royal commission.
As Shipton pulled his finger out of the levy, other departments began coming forward complaining of lack of funding. The Commonwealth Director of Public Prosecutions (CDPP) warned Attorney-General Christian Porter that it didn’t have the resources to handle the case load if banking executives were about to be taken to court. While ASIC conducts prosecutions of minor criminal matters, it refers more serious matters to the CDPP. However, under the gaze of the federal budget razor gang, Porter wasn’t about to dole out funds willy-nilly. ‘Once the final report of the royal commission is received, the government will consider its findings and recommendations and make any further decisions required, at that point,’ he said.
This position soon unravelled, and just days later the government was forced to scrounge together an extra $40 million for the CDPP.
APRA then came for the chequebook, asking for more money it said it needed to spend on installing its own supervisors inside large financial companies, and to boost its ability to respond to emerging issues such as cyber threats and the explosion of financially savvy ‘fintech’ start-ups that were disrupting the traditional financial sector. The requested $60 million funding boost to APRA’s budget was also going to be put towards an ‘enforcement review’ at the regulator, where an investigation would be launched into just how it had come to be so timid when dealing with the companies it was supposed to be regulating. The government agreed to hand over the money.
ASIC also got some emergency funding. In August 2018, it was given an extra $70 million to ‘embed’ some of its staff inside major companies. But the top-up was not enough. It had only just recovered the Abbott Government’s cuts to its budget. When Malcolm Turnbull took over the prime ministership, he had replaced the money Abbott took out in 2016, but this left ASIC in the same position it had started in. Medcraft said the problems in the financial sector caused by a regulator that didn’t have the money it wanted, nor the powers it was asking for, had been ‘brewing for a number of years’.
Over the past twenty years, the remit of ASIC had expanded considerably, as had the number of companies it regulated. By 2018, it had a wider regulatory remit than regulators in the UK, the US and Germany. The breadth of this responsibility increased the complexity of its operations, which required an appropriate amount of resourcing. The 2015 capability review of ASIC had found that only 15 per cent of external stakeholders believed the regulator was adequately funded.
This was one of the reasons ASIC was gun shy with court cases. It won 90 per cent of the cases it launched, but this in itself was a sign it was not willing to launch ‘test’ cases to clear up grey areas of the law. Litigation was expensive. And when it did take companies to court, the penalties were pathetic. Financial companies in the US and Europe can be fined billions of dollars from a single court case, but in Australia, they are slapped with wet lettuce. When enforced by ASIC, Australia’s penalty regime could only draw out fines in the tens of millions, if it was lucky to have a judge willing to punish banks to the full extent of the law, but when a bank was making profits of up to $10 billion a year, as was the case with Commonwealth Bank, such paltry penalties were simply factored into the cost of doing business. Australian penalties were not a deterrent.
Even when ASIC wanted to put executives in jail, the law was ill-designed to allow it to do so. ASIC chief prosecutor Daniel Crennan, QC, argued that federal laws would have to be overhauled to allow the regulator to launch criminal cases against executives and companies, because criminal legislation differed among the various Australian states. The government would need to extend the Federal Court’s jurisdiction to cover corporate crimes, and it belatedly launched a formal review of the legal system at the tail end of 2018. It also had to stump up an extra $10 million for the Federal Court of Australia to fund new judges and extra resources to handle the increased load of civil cases stemming from the royal commission.
Evidently, even if ASIC had wanted to launch criminal cases, the structure of the law precluded that from being a straightforward endeavour. The law remained out of step with what was necessary for ASIC to do its job, and the government was reluctant to hand it new powers to intervene in the free market.
The regulator had been demanding so-called ‘product intervention laws’ for years that would enable it to apply straight-out bans to products that were harmful to consumers. Examples of these included the insurance products Freedom Insurance was hawking and the useless credit insurance Commonwealth Bank had been selling. In 2014, the government’s own Financial System Inquiry had backed in the regulator and demanded the government amend the law to give ASIC the power to intervene, but by the end of 2018, the government had still not got around to doing so. By dragging its heels, it was allowing companies to continue selling deleterious products without any threat that ASIC would be able to stop them.
Even where the government did take action, it bungled the process and complicated ASIC’s work.
When Bill Shorten, as financial services minister in the Gillard Government, looked to bring in the FOFA laws, he made a significant compromise with the industry. The FOFA rules outlawed any new trailing commissions that could be charged to financial advice customers. These kickbacks totalled thousands of dollars a year per customer, and were paid in perpetuity until the customer got rid of whatever wealth management product they had bought, or if they died.
To ease the passage of the legislation through the parliament, Shorten allowed current trailing commission arrangements to be ‘grandfathered’, which meant advisers could continue to collect the payments on legacy products. It was thought the trailing commissions would wither on the vine and soon be banished from the industry, but the opposite happened. Portfolios of financial advice customers who were largely unaware they were continuing to be charged trailing commissions were traded around the sector by financial advisers. ‘The parliament has in effect put in place a provision that enables the continuing payment of commissions that generate conflicts of interest and unnecessary costs widely across the financial system,’ ASIC deputy Peter Kell told the royal commission.
Proposals to clamp down on the payday-lending sector were also victim to questionable political manoeuvres. ASIC had been lobbying the parliament to bring payday lenders under the remit of the Credit Act, which would give the regulator the power to clamp down on gouging and inappropriate products in the predatory sector.
But the government had sat on its own legislation targeting the sector for more than two years. The bill was passed among four different ministers during that time, and none managed to bring on the legislation for a vote to enshrine the proposals in law. The bill would have capped the amount payday lenders could siphon out of customers in interest charges, which were as high as 900 per cent. Customers—and they were often poorer Australians with limited access to formal credit products—were being sold into dozens upon dozens of loans with harsh terms and cripplingly high rates of interest.
Despite the urging of ASIC, consumer groups and financial counsellors, the government failed to enact the legislation. Indeed, it appeared beholden to lobbying from the payday-lending sector. Liberal MP Stuart Robert even met with payday lender Cash Converters before he was made assistant treasurer. When he was given responsibility for the legislation, it disappeared from the government’s agenda.
Meanwhile, ASIC was being forced to waste its time trying to bring the sector to heel through other means, and had spent resources taking action against lenders Thorn Group and Radio Rentals, Cash Converters and Nimble in separate enforcements.
When companies don’t act in the interests of consumers, public policy can be an important first line of defence to steer the behaviour back in the right direction. But the architects of Australia’s regulatory policy had failed to foster vigorous competition among financial companies. There was an inherent reluctance on the part of the government to allow large companies to lose any money, and this contributed to both the misconduct and the failure to tackle wrongdoing.
After banks survived the GFC and were ‘prudentially regulated against failure’, profit became their defining measure of success at the same time as they were ignoring the risk to their reputation, Hayne said in his interim report. ‘The law sets the bounds of permissible behaviour. If competitive pressures are absent, if there is little or no threat of enterprise failure, and if banks can and do mitigate the consequences of failing to meet obligations, only the regulator can mark and enforce those bounds,’ he said.
Since the late 1990s, Australia’s regulatory system had been hobbled by a disclosure-based free-market model of laws introduced after the government’s Wallis Financial System Inquiry in 1997. However, disclosure may well have proved to be a failed experiment. Customers were often inundated with disclosure documents riddled with fine print that were given to them at the wrong time, generally after they had been tricked into buying something. Companies were dumping customers into products and assuming they were absolved of all responsibility because of a few dot points in a 100-page product disclosure statement.
Hayne said the Wallis inquiry ‘reflected the prevailing conditions of deregulation and globalisation’ at the time, together with the view that competition in financial markets would diminish the role of banks and decrease costs for consumers. However, since Wallis the opposite had happened—‘banks’ accumulation of wealth management businesses accelerated’, Hayne said. The free market approach had only allowed the banks to become more powerful, and meanwhile the industry had exploded in size and complexity. All the while, APRA had only 200 front-line staff to monitor about 600 institutions.
In many cases, the most effective way to achieve regulatory simplicity would be to simply ban certain types of conflicts or conduct, rather than require burdensome disclosure and risk management rules that had the propensity to be uncertain or very costly. ASIC had long warned of such failures with the government’s laissez-faire approach. In 2014, ASIC commissioner John Price warned that the factors behind a rise in consumer losses ‘challenges some of the assumptions and philosophy underlying our financial regulatory system’. ‘In particular, the assumption that underpinned much of retail financial services regulation since the Wallis inquiry—that disclosure is the best tool in almost every instance to fix market failures—has not been borne out in practice,’ Price said.
When Hayne lectured ASIC on its failure to enforce the law, the regulator listened to the criticism and agreed it needed to take an ‘If not, why not?’ approach to litigation. When government MPs began to repeat the criticism, members inside ASIC were astounded. At nearly every point, ASIC had been hobbled by the government. Its budget had been slashed, appropriation of resources had been withheld or provided on a short-term basis, and legislation that was necessary for its ability to enforce the law had been killed off by politicians too close to the banking industry that donated to their parties.
Successive governments had let the banking industry off the leash and allowed it to run riot across the neighbourhood. When the watchdogs had failed to bark, it was because the government had muzzled them.